The all-important "interest on interest waiver" case comes up for hearing on Monday and it remains to be seen if the government’s and SBI’s lawyers are able to convince the court of the devastating impact of considering interest on interest a penalty.

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After the last hearing, the government appointed an expert committee under the chairmanship of the former CAG Rajiv Mehrishi to study and advise on the potential impact that waiving of interest and waiving of interest on interest would have on the economy and financial stability.

CNBC-TV18 had reported quoting sources, that the committee is of the view that charging interest on delayed interest payments is the bedrock of banking, and that it would be devastating for banks and their depositors if this was disallowed. It may also suggest that the government may consider paying the interest on interest from its own budget for small and vulnerable borrowers.

This Committee’s arguments are unexceptionable. Waiving interest on interest can be a dangerous precedent that can destroy Indian banking but if perchance, the court is still not convinced, it must appoint an Amicus Curiae like say a C Rangarajan or YV Reddy - to help it understand the ramifications of its decision in this case. ​(An amicus curiae literally means a friend of the court. It is someone who is not related to the parties to a case, and offers the court expertise, information and technical insights that have a bearing on the case.)

An Amicus Curiae is needed because waiving interest on interest, can be a reputational risk to the court and a huge financial risk to the economy. Here's why.

Charging interest on delayed interest payments is normal banking practice. If a borrower has to pay an interest of Rs 10,000 today, but he ends up paying that interest two years later, the value of that Rs 10,000 will be eroded by inflation. That’s why there is an interest charge levied on delayed interest payments.

​If as a rule, interest on delayed interest is waived, every borrower will opt to delay his interest, invest that money in other banks or mutual funds and earn interest on it. The borrow will then pay the bank his interest dues at a later date. And if every borrower were to choose to postpone paying, banks won’t be able pay depositors, who may, in turn, stop saving in banks altogether.

The bigger issue is who is paying for the waiver. The bank is an intermediary. It borrows from savers and lends to borrowers. If borrowers don’t pay up, the bank will pay depositors less, exactly at a time when the depositor is also COVID-hit and may need to fall back on their savings in the bank.

Alternatively, the bank has to make money from other borrowers whom it will charge more to make up for interest not paid by borrowers who sought moratorium. This is doubly unfair on those who have not sought moratorium because (a) They went through huge trouble, used up their existing savings, to pay interest and are now getting charged more, and (b)They have been treated unequally, inasmuch as were they aware of this waiver, they too would have sought moratorium.

The bigger issue here is that the Reserve Bank's effort to help the economy by cutting rates will be nullified since banks will have to raise interest rates on future borrowers to make up for this loss.

NBFCs will face an even bigger problem. They were not entitled to the moratorium, but they offered it to their COVID-hit borrowers. If interest on interest is waived, many NBFCs may fold, creating greater stress for the banking system and the economy.

If COVID-hit borrowers get such a huge benefit in terms of waiver of interest on delayed interest payments, this may become a precedent for all future defaults. After all, most defaults are because of unexpected distress: A borrower may be faced with a sudden fall in demand for his goods due to a global financial crisis, or a war between countries. A road project may be delayed because of political opposition to land acquisition; a mining or irrigation project may be hit by opposition from impacted villages. Will interest on delayed interest payments be waived in all cases?

Banks are commercial organisations that make money from borrowers and pay depositors. If they are prevented from charging for delays, they won’t be able to exist.

Vulnerable segments of society are historically protected by the state by charging taxes. The depositors’ savings in the bank are tax-paid savings, and cannot be used for public purposes.​

Usually, depositors are vulnerable individuals - small wage earners and pensioners, while borrowers - who borrow for cars or homes or their companies - are better off. A verdict to waive interest on delayed interest dues is effectively robbing the vulnerable to pay the better-off.

​In short waiving of interest on delayed interest payments strikes at the root of the banking system and can destroy it. It could also be an iniquitous decision in that it hits more vulnerable sections like depositors and other borrowers who are not represented in court.

More importantly, it can lead to a loss of confidence in the banking system, leading to savers shunning the banking system with devastating consequences for the economy.

​Hence, an Amicus Curiae is the need of the hour. He may be an experienced economic policymaker or a former RBI governor, in whom the court has confidence and who may help it understand that this case and its verdict can make or break the Indian economy.

First Published:Sept 27, 2020 5:14 PM IST